Common issues in non-ERISA disability insurance disputes

By Eric Buchanan

I. Introduction

Many private individuals, especially professionals and other highly-compensated people, have chosen to buy private disability insurance policies.  Often insurance companies pay benefits when the insured person becomes disabled and files a claim; but, sometimes, the insurance company decides that the claim is not compensable.  When an insurance company makes the decision not to pay a claim, the insured often seeks the help of an attorney.

Attorneys are often successful in helping the insured person explain to the insurance company why the person really does qualify for benefits under the policy.  But, sometimes, the insurance company and the insured don’t agree, and the case winds up in court.

Involving an attorney early on in this process can often help the insured person get the benefits her or she deserves at the earliest possible time, or can insure that all the correct steps are taken to make sure the issues are properly presented to the insurance company if the case needs to go to court.  Also, because some times the insured person is too sick or disabled to understand how to get the insurance company all the information it needs, insurance companies are sometimes grateful that an attorney has been able to help the insured to provide the insurance company the information it needs to pay a valid claim.

In those cases that cannot be resolved, many legal issues arise.  This paper will address some of the most common issues courts see regarding disability insurance disputes.

II. Purchasing the policy-the sales and application process.

A. The sales process:

Tennessee law defines a contract for insurance at TCA § 56-7-101. Contracts of insurance must cover a loss or damage "of something in which the other party has an insurable interest" Any insurance policy which covers "any property or interests or lives in this state, or with any resident thereof" must comply with Tennessee’s insurance law. Id.  Also, any solicitation, sale, issuance or "aid in the transaction of such insurance," by an insurance agent or broker must be done according to Tennessee law.  Under TCA § 56-7-102, any policy issued to a citizen or resident of this state "shall contain the entire contract of insurance between the parties to the contract" and shall be "construed solely according to the laws of this state."

Tennessee law requires that all policies must be in English. TCA § 56-7-123(a).  The law also states that if there is any difference in advertising for a policy and the actual policy, the terms of the policy control. TCA § 56-7-123(c).  However, "the use of any advertising or informational materials by any person, . . that materially contradict or misrepresent any provision of the underlying policy of insurance shall constitute an unfair and deceptive practice in the insurance business as provided by §§ 56-8-103 and 56-8-104."

B. The application process:

One of the most common disputes arises in these cases when a person files a claim, but the insurance company investigates and finds out that the person did not provide all the information that was requested on the application.  In those cases, the insurance company may try to rescind the policy or deny the benefits based on a claim of fraud in the application process.

Courts have held that giving the insurance company inaccurate information may be grounds to void the policy.  However, not all inaccurate information is grounds to avoid payment under the policy.  Tennessee law explains:

No written or oral misrepresentation or warranty therein made in the negotiations of a contract or policy of insurance, or in the application therefor, by the insured or in the insured's behalf, shall be deemed material or defeat or void the policy or prevent its attaching, unless such misrepresentation or warranty is made with actual intent to deceive, or unless the matter represented increases the risk of loss.

T.C.A. § 56-7-103.  Tennessee courts have explained that, any representation in application for insurance which naturally and reasonably influences judgment of insurer in making contract is misrepresentation that "increases risk of loss" within statute relating to voiding policy because of misrepresentations by insured. Lane v. Travelers Indem. Co., 499 S.W.2d 643 (Tenn. Ct. App. 1973).  Tennessee Courts have also explained that, if the statement is made with actual intent to deceive or represented increases the risk of loss it does not matter that the misrepresentation is unrelated to the cause of the loss. Bagwell v. Canal Ins. Co., 663 F.2d 710 (Tenn. 1981).  When it has been determined that answers contained in insurance application were untrue it becomes question of law for court as to whether such misrepresentation materially increased risk of loss. Id.

If an insurance company seeks to rescind a policy or to deny coverage due to false information on the application, the insurance company must prove that 1) that the insured’s answers on the insurance application were false, and 2) either that insured provided false answers with the intent to deceive the insurer or that the false answers materially increased the risk of loss.  McDaniel v.Physicians Mut. Ins. Co., 621 S.W.2d 391, 393 (Tenn. 1981); Womach v. Blue Cross & Blue Shield, 593 S.W.2d 294, 295 (Tenn. 1980); see also Kentucky Central Life Ins.Co. v. Jones, 799 F. Supp. 53, 55 (M.D. Tenn. 1992).  If the insurance company attempts to deny a claim on these grounds, the burden of proof is on the insurance company.  Cummings v. Fed. Kemper Life Assurance Co., 908 F. Supp. 512, 514 (E.D. Tenn. 1995).

When an insurance company claims an application contained a materially false statement, one of the most common responses from the person who bought the policy is that the person says either, "well, I told my agent about that, and he or she told me ‘not to worry about it.’"  Another common response is, "I told my agent about that, and I thought my agent included that in the application."  When these situations arise, it may be up to a court to decide whether the person really told the agent about the missing fact. If the person can prove the agent knew of the fact, then the insured can argue that the insurance company is deemed to have that knowledge.

The general rule in Tennessee is that a person who solicits or negotiates a policy is considered an agent of the insurance company.  The law states:

(b) An insurance producer who solicits or negotiates an application for insurance shall be regarded, in any controversy arising from the application for insurance or any policy issued in connection therewith between the insured or insured's beneficiary and the insurer, as the agent of the insurer and not the insured or insured's beneficiary. This provision shall not affect the apparent authority of an agent. 

T.C.A. § 56-6-115.[1] See also, Ebbtide Corp. v. Travelers Ins. Co., 2001 WL 856578, *6 (Tenn. Ct. App. 2001) (tracing the predecessors of this rule previously codified as T.C.A. § 56-6-147 (repealed 2003), 56-6-124 (repealed 1988), and T.C.A § 56-705 (repealed 1975.));  See also, Cheek v. American Eagle Fire Ins. Co., 6 Tenn. App. 632 (Tenn. Ct. App. 1928) (noting that this rule was originally codified as Chapter 442 of the Acts of 1907, or section 3275a2 of Shannon's Annotated Code). 

If the person can prove he told his or her agent, then courts have held that is enough to give the insurance company knowledge of the fact, such that the insurance company cannot use this to deny coverage.  For example, in American General Life Ins. Co. v. Gilbert, 595 S.W.2d 83 (Tenn. Ct. App. 1979), the court explained that, under the state law in Tennessee, the knowledge of soliciting agent is imputed to the insurer, the only exception being where third party is acquainted with circumstances clearly indicating that the agent would not advise his principal.

However, some courts have held that the purchaser of the policy can still be denied coverage when the insurance agent doesn’t write everything down that the agent is told, and the purchaser signs it anyway. See, e.g., Giles v. Allstate Ins. Co., Inc., 871 S.W.2d 154 (Tenn. 1993) (Denial of recovery under homeowner's policy for items stolen from insured's residence was proper because of material misrepresentation in application for insurance, where insured allegedly correctly answered questions about her previous fire losses and refusal of her prior carrier to renew policy, but where agent allegedly listed incorrect answers on application, and insured signed application without reading it.)

III. When does the purchase of a policy create an employee benefit plan under ERISA?

Sometimes, when a person purchases a private disability insurance policy, the policy may inadvertently become an employee benefit, and subject to ERISA, which is a much worse area of the law for the insured.

Generally speaking, ERISA may apply to a policy if it provided through work.  Therefore, insurance agents should avoid recommending to the insureds to pay for policies through work, or through company checks, or to otherwise involve the employer in the purchase of a private disability policy.

A. What is ERISA?

If an insured person obtained his or her insurance coverage at work, then any claim under that policy may be preempted by the Employee Retirement Income Security Act of 1974 (ERISA).  For example, claims for long-term disability benefits, life insurance or health insurance benefits are ERISA claims in most cases, if the insurance was provided through work. 

ERISA is a comprehensive Federal statute that applies to many claims related to employee benefits.  ERISA is a complicated area of the law that throws up many hurdles that stand between employees and their insurance benefits if the insurance coverage is provided as an employee benefit.

The intent of Congress in enacting ERISA was to protect the "interest of participants in employee benefit plans . . . by establishing standards of conduct, responsibility, and obligation for fiduciaries of employee benefit plans, and by providing for appropriate remedies, sanctions, and ready access to the Federal courts. ."  29 U.S.C. § 1001(b).  The language of the ERISA statute draws heavily from trust law as well as contract law. Congress instructed the courts to develop a common law of ERISA, using both trust and contract principals. The Department of Labor also has authority to issue regulations governing the processing of ERISA claims.

B. ERISA Preemption

ERISA "shall supersede any and all State laws insofar as they may now or hereafter relate to any employee benefit plan ... ." ERISA § 514(a), 29 U.S.C. § 1144(a). A saving clause then provides that some state laws are not preempted: "nothing in this subchapter shall be construed to exempt or relieve any person from any law of any State which regulates insurance, banking, or securities." ERISA § 514(b)(2)(A), 29 U.S.C. § 1144(b)(2)(A). 

ERISA preemption means that almost all employee benefits plans that provide such benefits as health insurance, life insurance or disability insurance are preempted by Federal ERISA law; however, plans sponsored by governmental employers and churches are not usually preempted by ERISA. 

Once an insurance policy is found to be an ERISA plan, almost all claims under state law are preempted, and the insured can only recover the benefits due to him under the policy, and maybe, attorneys fees.  Under the federal ERISA case law, the insured must exhaust his appeals with the insurance company, has no right to a jury trial, gets only very limited discovery, and cannot submit additional evidence to support his or her claim in court.  Also, the court will usually give the benefit of the doubt to the insurance company under an arbitrary and capricious standard of review.

C.What is an "employee benefit plan?"

ERISA benefits fit into two broad categories: employee pension benefit plans and employee welfare benefit plans.  Insurance benefits are provided to employees through welfare benefit plans.  ERISA defines a welfare benefits plan in ERISA §3, 29 U.S.C. § 1002 as follows:

The terms "employee welfare benefit plan" and "welfare plan" mean any plan, fund, or program which was heretofore or is hereafter established or maintained by an employer or by an employee organization, or by both, to the extent that such plan, fund, or program was established or is maintained for the purpose of providing for its participants or their beneficiaries, through the purchase of insurance or otherwise, (A) medical, surgical, or hospital care or benefits, or benefits in the event of sickness, accident, disability, death or unemployment, or vacation benefits, apprenticeship or other training programs, or day care centers, scholarship funds, or prepaid legal services. . .

D. When is a plan "established or maintained?"

While ERISA § 402(a)(1), 29 U.S.C. § 1102(a)(1) states that "every employee benefit plan shall be established and maintained pursuant to a written instrument," courts have held that an ERISA plan may exist even without a written plan.  The Court of Appeals for the Eleventh Circuit explained that, "ERISA does not . . . require a formal, written plan."    Donovan v. Dillingham, 688 F.2d 1367, 1372 (11th Cir. 1982)(en banc). The Dillingham Court set out the test to determine if an ERISA plan was established: "a ‘plan, fund, or program’ under ERISA is established if from the surrounding circumstances a reasonable person can ascertain the intended benefits, a class of beneficiaries, the source of financing, and procedures for receiving benefits." Id, at 1373.     
The Dillingham test has been adopted by every circuit, and is the most cited case on haw to determine if a "plan" has been established. Jayne E. Zenglein, ERISA Litigation 8 (The Bureau of National Affairs 2003);

When the employer pays the premiums, that is almost universally held to be an ERISA plan.  See generally, Jayne E. Zenglein, ERISA Litigation 13 (The Bureau of National Affairs 2003); see also Fugarino v. Hartford Life and Acc. Ins. Co., 969 F.2d 178, 183 (6th Cir. 1992) (abrogated on other grounds in Yates v. Hendon, 541 U.S. 1, 124 S.Ct. 1330, 159 L.Ed. 40 (2004)) and Randol v. Mid-West Nat. Life Ins. Co. of Tennessee, 987 F.2d 1547, 1551-2 (11th Cir. 1993).

E. Who is covered under an ERISA plan?

1. Employees are covered.

ERISA § 3(7), 29 U.S.C. § 1002(7) defines a "participant" as "any employee or former employee of an employer, ... who is or may become eligible to receive a benefit of any type from an employee benefit plan which covers employees of such employer ..., or whose beneficiaries may be eligible to receive any such benefit."  An "Employee," is defined as "any individual employed by an employer," ERISA § 3(6), 29 U.S.C. § 1002(6). 

2. Independent Contractors are not covered.

A person must be an "employee" to be covered by an ERISA plan. In Nationwide Mutual Insurance Company v. Darden, 503 U.S. 318, 112 S.Ct. 1344, (1992) the Supreme Court adopted the "common law" definition of an "employee" using traditional agency law principals. Id at 323.

3. Employers may or may not be covered.

The general rule addressing whether an employer is also an "employee" and covered by ERISA is whether or not other employee are also covered under the plan.  Yates v. Hendon, 541 U.S. 1, 124 S.Ct. 1330, 1335, 159 L.Ed. 40 (2004).  The ERISA regulations explain that:

(1) An individual and his or her spouse shall not be deemed to be employees with respect to a trade or business, whether incorporated or unincorporated, which is wholly owned by the individual or by the individual and his or her spouse, and

(2) A partner in a partnership and his or her spouse shall not be deemed to be employees with respect to the partnership.

29 C.F.R. § 2510.3-3(c). 

4. Benefits provided by governmental entities are not ERISA "plans."

ERISA § 4(b), 29 U.S.C. § 1003(b) states that the provisions of ERISA "shall not apply to any employee benefit plan if—(1)such plan is a governmental plan (as defined in § 3(32)).  That section further defines a governmental plan as: "a plan established or maintained for its employees by the Government of the United States, by the government of any State or political subdivision thereof, or by any agency or instrumentality of any of the foregoing." ERISA §3(32), 29 U.S.C. § 1002(32).

5.Church plans are not "ERISA" plans unless the employer "opts in" to ERISA.

ERISA § 4(b)(2), 29 U.S.C. § 1003(b)(2) likewise exempts "church plans (as defined in §3(33) with respect to which no election has been made under §410(d) of the internal revenue code. . ."  A Church Plan is "a plan established and maintained (to the extent required in clause (ii) of subparagraph (B)) for its employees (or their beneficiaries) by a church or by a convention or association of churches which is exempt from tax under section 501 of Title 26." ERISA §3(33), 29 U.S.C. § 1002(33). "An organization, whether a civil law corporation or otherwise, is associated with a church or a convention or association of churches if it shares common religious bonds and convictions with that church or convention or association of churches." ERISA § 3(33(C)(iv), 29 U.S.C. § 1002(33)(C)(iv).

IV. Applications for benefits

If an insured thinks he or she might have a claim, they should file a claim as soon as reasonably possible.  Tennessee law provides specific language that a policy should set out about when a claim should be filed:

Proof of Loss. Written proof of loss must be furnished to the insurer at its office in case of claim for loss for which this policy provides any periodic payment contingent upon continuing loss within ninety (90) days after the termination of the period for which the insurer is liable and in case of claim for any other loss within ninety (90) days after the date of such loss. Failure to furnish such proof within the time required shall not invalidate nor reduce any claim if it was not reasonably possible to give proof within such time; provided, that such proof is furnished as soon as     reasonably possible and in no event, except in the absence of legal capacity, later than one (1) year from the time proof is otherwise required.

Tenn. Code Ann. § 56-26-108(7).  If a claim is not filed on time, the insurance company can only deny the claim if the insurance company was prejudiced by the late filing.  Alcazar v. Hayes, 982 S.W.2d 845, 856 (Tenn. 1998)   

VI. Coverage problems

Many policies provide for the exclusion from coverage of certain conditions.  For example, a policy may exclude pre-existing conditions.  A sample of such language might read:

"Pre-Existing Condition" means that your received medical treatment, consultation, care or services including diagnostic measure, or took prescribed drugs or medicines for your condition in the three months just prior to the Date of Issue of Your Policy; or you had symptoms for which an ordinarily prudent person would have consulted a health care provider during the three months just prior to the Date of Issue of Your Policy.

Some policies may also limit coverage only to those illnesses and injuries which occur after the policy is issued.  This exclusion is referred to as the "first manifest" exclusion, which basically means the policy only covers those injuries or sicknesses first occur (i.e are "first manifest") after the policy is in place.  Sample language would be:

"Injury" means accidental bodily injury sustained after the Date of Issue and while Your Policy is in force.
"Sickness" means sickness or disease which first manifests itself after the Date of Issue and while Your Policy is in force.

V. Claims handling

When an insurance company considers a claim, it must comport with certain principles.  An example of such principles can be found at the International Claim Association (ICA) website (http://www.claim.org/index.htm).  The website explains:

As a condition of ICA membership, every company must agree to adhere to this Statement of Principles:
The International Claim Association, in recognition of the need to continue public trust and confidence in the insurance industry, reaffirms the following principles:

1. Any individual who has, or believes he has, a claim is entitled to courteous, fair and just treatment; and shall receive with reasonable promptness an acknowledgment of any communications with respect to his claim.
2. Every claimant is entitled to prompt investigation of all facts, an objective evaluation and the fair and equitable settlement of his claim as soon as liability has become reasonably clear.
3. Claimants are to be treated equally and without considerations other than those dictated by the provisions of their contracts.
4. Claimants shall not be compelled to institute unnecessary litigation in order to recover amounts due, nor shall the failure to settle a claim under one policy or one portion of a policy be used to influence settlement under another policy or portion of a policy.
5. Recognizing the obligation to pay promptly all just claims, there is an equal obligation to protect the insurance-buying public from increased costs due to fraudulent or nonmeritorious claims.
6. Procedures and practices shall be established to prevent misrepresentation of pertinent facts or policy provisions, to avoid unfair advantage by reason of superior knowledge, and to maintain accurate insurance claim records as privileged and confidential.
7. Reasonable standards shall be implemented to provide for adequate personnel, systems and procedures to effectively service claims. These standards shall be such as to eliminate unnecessary delays or requirements, overinsistence on technicalities, and excessive appraisals or examinations. Claim personnel shall be encouraged and assisted in further developing their knowledge, expertise, and professionalism in the field of claim administration.

About the author:

Eric Buchanan represents policyholders nationally in both ERISA and non-ERISA disputes, especially in the areas of disability, life and health insurance.  He also represents disabled people before the Social Security Administration, having represented approximately 1200 people in Social Security hearings.  In 2007 Eric Buchanan was certified as a specialist in Social Security Disability Law by the Tennessee Commission on Continuing Legal Education and Specialization.

Eric Buchanan regularly speaks to both national and local audiences on disability insurance, ERISA, disability litigation and Social Security disability.

Eric is the immediate past-chair (2007-2008 chair) of the AAJ (formerly ATLA) Social Security Disability Section, past chair (2006-2007 chair) of the AAJ Health Care Finance and Disability Litigation Group, is a past President of the Chattanooga Trial Lawyers, and is past-chair (2005-2006 chair) of the Tennessee Bar Association Disability Law Section.  He is a life-time member and executive committee member of the Board of Governors of the Tennessee Association for Justice (formerly TTLA).

Eric graduated from the Washington and Lee University School of Law Magna Cum Laude; while in Law school he was also inducted into the Order of the Coif and the Omicron Delta Kappa honorary leadership fraternity.  Eric is also a graduate of the Virginia Military Institute, and served as an officer in the U.S. Navy from 1989 to 1994 where he served as a naval aviator and plane commander of P-3C Orion aircraft.

Eric may be reached at his office at 414 McCallie Ave, Chattanooga, Tennessee, 37402.  His phone number is (423) 634-2506 or (877) 634-2506.  He may be contacted by e-mail at ebuchanan@buchanandisability.com. His firm’s website is at www.buchanandisability.com.

[1] Of note, the current formulation of the rule announced in 56-6-115 applies to "insurance producers," while its predecessor, 56-6-147, applied only to "insurance agents or limited insurance representative."  This is a defined term under Tennessee Insurance Producers Liability Act.  An insurance producer "means a person required to be licensed under the laws of this state to sell, solicit or negotiate insurance."  T.C.A. § 56-6-102(6).  In changing the statute to apply to "producers" rather than "insurance agents or representatives," it would appear that the legislature intended to expand the group governed by the law to include any licensed individual who solicits an application.  Additionally, "solicit" is defined in the Act as "attempting to sell insurance or asking or urging a person to apply for a particular kind of insurance from a particular company."  T.C.A. 56-6-102(17).  The Act defines negotiates as: "the act of conferring directly with or offering advice directly to a purchaser or prospective purchaser of a particular contract of insurance concerning any of the substantive benefits, terms or conditions of the contract; provided, that the person engaged in that act either sells insurance or obtains insurance from insurers for purchasers." T.C.A. § 56-6-102(14). [return to text]